An individual is currently working 40 hours per week, earning $10 per hour. He loses his job and successfully applies for unemployment insurance. The insurance plan works as follows:
The receives a weekly benefit equal to 50 percent of his earnings prior to losing his job (i.e., the benefit level is $200 per week).
The is allowed to earn income while receiving unemployment benefits. If he earns an amount up to ¼ of pre-unemployment earnings, his benefit is unaffected. If he earns more than than ¼ but less than ½ of pre-unemployment earnings, his weekly benefit is cut in ½, to $100. If he earns more than ½ of pre-unemployment earnings, he no longer receives a benefit.
a. Illustrate this individual's budget constraint in a carefully labelled graph. For simplicity, assume that he is able to earn a wage of $10 per hour while on unemployment and that there is no unearned income except for unemployment insurance benefits.
b. Show that it would be economically irrational for unemployment insurance recipients to want to work more than 10 hours per week. Show that this program might induce individuals to leave full-time jobs in order to receive unemployment insurance benefits.